Inheriting IRAs Just Got Complicated, Thanks to New Retirement Overhaul
The new spending package, passed on January 1, 2020, curtails the Stretch IRA, a popular strategy for passing on tax-free growth to younger heirs. Many Americans planned their estates around the fact that taxable money passed on to heirs would have to be withdrawn according to the heir’s life expectancy. That allowed beneficiaries to “stretch” out their tax burden over many years rather than a few. No more. Now non-spouse heirs have a maximum of 10 years to withdraw an inheritance.
If this sounds complicated, it simply means a large, backdoor tax hike. Let’s consider an example: let’s say you die (or another relative) and pass a $500,000 IRA to your 30 year-old son. Under decades of previous law, your son would have to take required minimum distributions over 53 years. The first year RMD would be $9433. Taking the minimum would be wise if your son didn’t need the money, so he could let the money grow more. Further, what if he was in his peak earning years and he was in a high tax bracket, like 28% or even 37%? He’d still have no choice but to take a 28% of 37% tax hit on the money. The extra money might also push him into an even higher bracket.
This legislation, passed overwhelmingly, unraveled thousands of estate plans and amounts to a major tax grab. Even passing on a Roth IRA isn’t immune. Although tax-free, the Secure Act still forces the timely liquidation of an IRA. That means people will have to figure out where to place the freed up money. Unless they are very financially savvy, that freed up money will likely be invested in another vehicle which then will subject to taxes.
The three takeaways from this topic are:
1) The government doesn’t need to pass unpopular legislation in order to raise taxes. The Secure Act is an example.
2) Once the government foot is in the tax door, it’s easier to blow it wide open. Now that The Secure Act has passed, it will be much easier to reduce the 10-year time horizon to a 5 or 0-year horizon. Congresspeople also want to tax the on-paper balances of IRAs, including Roths!
3) We have a place for that after-tax money, where neither the gains nor the distributions will ever be taxed again.